Crisis Looming At The ECB?

A right royal row is brewing at the ECB. Basically the old guard theorists of the ‘one size fits all’ monetary policy are being challenged by more pragmatic observers of day to day realities. For the moments it is the politicians who are making the running (but there are plenty of competent economists in Germany and Italy who are ready to back them up), and yesterday the OECD joined the fray.

Wolfgang Clement, Germany’s economics and labour minister, supported the OECD’s conclusions about Europe, joining Italian ministers in urging the ECB to loosen monetary policy.

At the other end there is eg Erkki Liikanen:

In an interview in today’s Financial Times, Erkki Liikanen, governor of the Bank of Finland and a member of the ECB’s governing council, reiterated the ECB’s view that the next move in European rates would be up.

Or you have the theorist of the old guard over at the ECB Otmar Issing:

European Central Bank chief economist Otmar Issing said euro zone growth differentials have to be addressed by national economic policies rather than by the ECB’s interest rate policy.

In fact Issing is really digging in. He provocatively gave this One Size Fits All speech on 20 May. His conclusions were as follows:

“Let me conclude with a citation. On the eve of the changeover, I wrote a commentary on diversity and monetary policy in the euro area. To the question whether a single one-size monetary policy could fit all parties involved ? be they national entities, social partners or economic actors ? my answer was: ?One size must fit all?. The political decision on the creation of EMU had resolved all discussions on whether monetary union should precede or follow political unity and the fulfilment of the criteria for an optimum currency area. Today, in light of the evidence gathered so far in the euro area, I am more confident in saying: ?One size does fit all!?”

Obviously you have to ask whether Issing in now losing his grip on reality. Can one size fit all is a legitimate question, one size must fit all is not an adequate response, and one size *does* fit all seems to reflect a distorted vision of reality to say the least. Clearly Issing has a lot personally at stake in the euro process, but obviously, as we can see from political life, inability to reform and address real life issues normally leads to even bigger changes later. My feeling is that it will not be long before heads will roll at the ECB.

As the FT notes:

The ECB has insisted that a rate cut would be harmful and was not supported by sensible economists. Jean-Claude Trichet, the ECB president, told the European Parliament on Monday: ?The last time we met, we were absolutely convinced that we would not improve the situation [with a rate cut] but that we would hamper Europe if we would go in the direction that is suggested by some.?

But now that the OECD, a bastion of orthodox economic thought, has flatly contradicted the ECB’s position, Mr Trichet will find it more difficult in future to reject out of hand a discussion of lower rates.

I don’t know if I count as a sensible economist or not, but this situation has long been clear to me. Personally I welcome the prospect of a new broom sweeps clean over in Frankfurt. This problem has been obvious for a long time, and it is better to address it sooner rather than later.

Update : Just to give us a measure of who is and who isn’t considered a ‘sensible economist’, one might look at today’s statement from Hans-Werner Sinn, President of Germany’s prestigious Ifo index: he is reported as telling CNBC that: “the ECB has done a good last year in keeping interest rates stable, ?but we have a different situation now and the ECB should cut interest rates?.

This situation is not without its comic aspect: Sinn means sense, ie he is the real, true to life, sensible economist.

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About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

7 thoughts on “Crisis Looming At The ECB?

  1. Can one size fit all is a legitimate question, one size must fit all is not an adequate response, and one size *does* fit all seems to reflect a distorted vision of reality to say the least.

    What do you expect? If the answer were “no”, the logical response would be drastic indeed.

  2. “If the answer were “no”, the logical response would be drastic indeed.”

    That’s just what I think it’s going to be Oliver. I think first we need to see what happens this Sunday, then possibly next week all this will start to become clearer.

    I’ve just no idea how they could ever have imagined that one size could fit all, no idea at all.

  3. It seems to me that the issue here is not so much whether ‘one size fits all’ in the Eurozone. Instead, the debate is about the ECB’s rather stubborn insistence on maintaining price stability over all other policy goals. There was once a time when central bankers could target employment growth as a legitimate goal of monetary policy. In an environment of slow economic growth and high unemployment in the major Eurozone economies, the ECB would do well to consider that its credibility can be damaged just as much by low economic growth numbers as by rising inflation.

  4. “There was once a time when central bankers could target employment growth as a legitimate goal of monetary policy.”

    Would that there world were that simple bc. Not all countries have employment growth problems: Ireland and Spain for eg.

    What you have to think about too are those countries like Greece and Spain who have ongoing inflation around the 3.5% mark. These countries are systematically losing their competitiveness and without their own currency to devaluate there isn’t much they can do about it.

    The main case for a rate reduction is Germany, I think Italy is a separate case that needs a different discussion. So what we are really saying is put Germany’s interest first. I would agree, given the gravity of the German situation, and the specific weight of Germany in the eurozone, but it isn’t evident to me that everyone is agreed about this.

    There is also the trade balance element to consider. Some countries are fine (Germany) but several others Spain, Portugal, Greece have deteriorating accounts, and lowering the rate in these countries may suck in more imports as much as it create jobs. EU wide the trade surplus deteriorated from a 10.4 billion euro surplus last March (2004) to a 4.2 billion one this March. At this rate we’ll collectively be running a deficit next year. The ECB also has to be mindful of this.

    It’s just so, so complicated. Which is why I would never have set the damn thing up in the firts place.

  5. “It’s just so, so complicated. Which is why I would never have set the damn thing up in the firts place.”

    I agree with you Edward.

    It isn’t enough that the Eurozone is full of imbalances at present. There is also the not insignificant point that the Eurozone is not a nation state with a single government, and single set of economic policies – the national interests of Eurozone members are often at variance….not to mention the matter of electoral cycles and the impact they tend to have on EMU member states economic policy.

    Monetary union without having first put in place political union was never going to be easy.

  6. Empirical question — are the divergences among the eurozone economies greater than among other monetary unions?

    I am thinking particularly of Canada, but anyone familiar with the United States in the 1970s, 1980s and early 1990s might also wonder.

    I do not know the answer. I do know that most of other monetary unions allow for large fiscal transfers, but that’s not really the question.

  7. “are the divergences among the eurozone economies greater than among other monetary unions?”

    Well there is one thing I want to say first of all, and that is I don’t think there are other monetary unions in the same way there is the euro. For me it is unique, and an experiment. And, as with all experiments, when the time comes, we will be able to make a full evaluation.

    Meanwhile we should just try and get by from day to day.

    On divergencies, at present there are probably great similarities between the differences inside the EU and the US, although if the Central European countries enter the euro then the divergencies will become greater, however – apart from Poland – the population numbers are so small that it probably won’t make too much difference.

    Now, if we are going to talk about Canada and the US as monetary unions, then the EU equivalent of this would be the Federal Republic of Germany. Especially after the fusion of the ex-DDR. Should all of Europe become a single Federal state like the German or US or Canadian one, well maybe, long term, that would be fine with me. But as you we see on Sunday and next Wednesday, a great many Europeans don’t agree with this, and I respect their right to feel the way that they do, so I think we are a long way away from that.

    Another type of ‘virtual’ monetary union where one of the parties seems to want a divorce would be the dollar-renminbi peg. Actually there are even nominal fiscal transfers, since one of the parties carries part of the debt of the other, but I think we’re all agreed that this ‘union’ should come to an end at some stage. That being said, the love hate relationship that is going on between the US and China right now is a lot nearer to EU realities than the US or Canada is.

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